Pricey Tobacco Pushes Up Core Producer Inflation

Core producer prices rose at their fastest pace in six months in July on strong tobacco and light truck costs, though weak domestic demand was seen keeping inflation pressures under control.

The Labor Department said on Wednesday its seasonally adjusted index for prices paid at the farm and factory gate, excluding food and energy, rose 0.4 percent -- the largest increase since January -- after rising 0.3 percent in June.

Economists, who had expected a 0.2 percent rise last month in the so-called core rate, said July's gain should not alter the Federal Reserve's prediction of low inflation in the near-term. Producers' pricing power is limited by a 9.1 percent unemployment rate.

"There is a high level of unemployment and low level of capacity utilization," said Christopher Probyn, chief economist at State Street Global Advisors in Boston. "I don't think that the U.S. economy is in a position to generate a sustained acceleration in inflation."

The Fed last week promised to keep interest rates near zero for the next two years to stimulate growth, saying the outlook for inflation over the medium-term was subdued.

The U.S. central bank has suddenly come under harsh scrutiny from Republican campaigners for the 2012 presidential nomination who say its easy money practices and lack of transparency are a threat to national economic stability.

Texas Governor Rick Perry even suggested on Monday that Chairman Ben Bernanke's policies could be considered "treasonous" if the Fed "prints more money between now and the election" in November 2012.

The Fed has injected about $2.3 trillion into the economy through purchases of government and agency debt since late 2008, measures intended to increase credit availability, but that some see as setting the stage for future inflation.

TOBACCO PRICES SURGE

U.S. stocks rose on strong earnings and a jump in oil prices, while U.S. government debt prices were little changed.

A spike in food and energy prices pushed up inflation early this year, but weak economic growth and high unemployment kept underlying price pressures contained.

In the 12 months to July, core producer prices increased 2.5 percent, the largest rise since June 2009.

The economy hardly grew in the first half of 2011 and a moderate expansion pace is expected for the rest of the year.

But some economists cautioned that regardless of anemic demand, the Fed could find itself with an inflation problem.

"Producer expenses are on the rise and while weak demand may limit pricing power, the pressure on costs will cause firms to look for any way possible to pass on those increases," said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania.

"The Fed's policy is likely to produce higher than desired inflation in the future and I would not be surprised to see the Fed's most closely watched indices all exceed the upper end of the target range by year's end."

Tobacco accounted for almost a quarter of the rise in the monthly core PPI rate, with light motor trucks and pharmaceuticals also making significant contributions.

Tobacco surged 2.8 percent, the largest increase since March 2009. Light truck prices increased 1 percent, still reflecting the lingering effects of disruptions to production caused by the March earthquake in Japan.

However, motor vehicle production rebounded strongly in July, which should help to ease the price pressure.

Overall prices received by producers rose 0.2 percent last month, above economists' expectations for a 0.1 percent gain, after falling 0.4 percent in June.

Overall producer prices were bumped up by food costs, which rose 0.6 percent as potatoes recorded their biggest increase in almost a year. Gasoline prices, however, fell 2.8 percent.

In the 12 months to July, producer prices rose 7.2 percent after increasing 7.0 percent the prior month. The rise was above economists' expectations for a 7.0 percent advance.